State Government Catastrophe Risk Financing and the Capital Markets

In recent years, certain states facing a high probability of catastrophic hurricane and earthquake exposures have added the burden of socializing the risk of individual and business property losses instead of leaving these private actions subject to voluntary insurance markets. In turn, these state governments have created financial intermediaries with access to the capital markets to transfer risks back to individuals and businesses some of which had those risks to begin with but in a new form (such as an excise tax‐like levy) that serves to spread the risks among policyholders and investors. In the process, however, these state‐sponsored intermediaries create financial risks for the host state government, including, but not limited to, constraints on debt market capacity. Financial intermediary theory frames the evaluation criteria applicable to state‐created catastrophe risk financing entities. Case studies of three exposure‐prone states (Florida, Louisiana and California) detail their catastrophic risk financing through the capital markets. This comparative analysis of different policy designs is then evaluated by public financial management theory. In the last section, policy implications of these capital market approaches are discussed